Household Leverage and the Recession

Atif Mian and Amir Sufi offer “Household Leverage and the Recession of 2007 to 2009″ (older ungated draft here) which uses county-level data to demonstrate a connection between the scope of household indebtedness and the onset of the recession:

We sort counties according to the increase in the household debt to income ratio from 2002 to 2006, and we refer to counties with large (small) increases in leverage during this period as high (low) leverage growth counties. We find that the recession both began earlier and became more severe in high leverage growth counties relative to low leverage growth counties. The top 10% leverage growth counties experienced an increase in the household default rate of 12 percentage points and a decline in house prices of 40% from the second quarter of 2006 through the second quarter of 2009. In contrast, the bottom 10% leverage growth counties experienced a modest increase of 3 percentage points in the default rate and a 10% increase in house prices.

Auto sales and new housing building permits reveal a similar pattern. By the third quarter of 2008, auto sales in the top 10% leverage growth counties declined by almost 40% relative to 2005. In contrast, auto sales in the bottom 10% leverage growth counties were actually up almost 20%. From 2005 to 2008, new housing building permits declined by almost 150% in high leverage growth counties while declining only 50% in low leverage growth counties. To the best of our knowledge, we are the first to examine durable consumption and residential investment patterns across U.S. counties during a recession, and the first to show the link between household leverage and the decline in these variables.

The final measure of economic activity we examine is the unemployment rate. Similar to the pattern in auto sales, the unemployment rate increased in high leverage growth counties much earlier than low leverage counties. From the fourth quarter of 2005 to the third quarter of 2008, the unemployment rate climbed 2.5 percentage points in the top 10% leverage growth counties; in contrast, the bottom 10% leverage growth counties experienced no change in unemployment.

In a sane world, the run-up in household leverage would have been universally greeted as a somewhat alarming trend. In the real world, however, the political right’s zeal to wave this issue away led most right-of-center folks to embrace the theory that consumption was all that mattered, so growing indebtedness was good. I think it’s wrong to say that we had the crash “because” of stagnating incomes, but the stagnation and the unwillingness of political elites to confront it was a key backdrop of the political economy of the crisis. It made it unthinkable and impossible for the people running the country to see what should have been an obviously problematic situation.